Green investors look at potential pitfalls

Published August 6th, 2012 - 01:19 GMT
Operators of renewable energy projects are often small, privately held and sub-investment grade
Operators of renewable energy projects are often small, privately held and sub-investment grade

Alternative energy is turning out to be unhappy hunting ground for stock-picking fund managers as the small scale of energy projects forces them to turn to bigger manufacturers and technology companies vulnerable to the economic downturn.

The decentralized model of alternative power generation can be a bonus, cutting grid transmission losses and construction times, but it can also be a burden for investors, particularly during a downturn that favors defensive stocks.

The experience of BlackRock's New Energy Fund, one of the longest established and most experienced of environmental market specialists, illustrates the downside of taking a public equity approach that focuses on alternative energy.

Like many of its peers, it has underperformed wider energy and global equity benchmarks, generating negative annual returns over the past five years. Its results for the first six months of this year showed a 5 percent fall. The trouble is that a focus on pure-play alternative energy is biased towards wind and solar equipment manufacturers.

These are the biggest and best researched companies in the sector but they are also the worst performers as brutal competition from Chinese rivals and their dependence on dwindling subsidies have combined to hammer margins.

As BlackRock New Energy Fund managers reported on its last quarterly performance: "The portfolio's exposure to renewable energy technology companies such as (Danish wind turbine marker) Vestas detracted from performance." Vestas has fallen nearly 60 percent this year, while another BlackRock portfolio company, Chinese solar manufacturer Yingli, is down 63 percent.

Wind power capacity grew by 24 percent and solar capacity by 42 percent annually from 2000-2011, and their robust expansion rested in part on the same drops in equipment prices that have hammered manufacturers.

The problem for investors is accessing returns from generating assets given their small size. Operators of renewable energy projects are often small, privately held and sub-investment grade.

To illustrate scale, Britain's biggest coal plant, Drax, has a nameplate generating capacity of 3.9 gigawatts (GW) and sold some 13.6 terrawatt hours (TWh) of electricity in the first half of 2012. That is close to the reported 14.7 TWh of power generated by Germany's entire solar industry, the world's biggest, over the same period. But Germany's solar power was generated by around 1.2 million systems in solar parks and on rooftops, compared with a single coal-fired power plant. The wind market is typically deployed in farms of around 50 megawatts.

These assets have performed well, in line with other privately held infrastructure assets such as toll roads, airports, schools and hospitals, private equity investors say, without detailing numbers.

Larger, listed specialist operators of renewable energy can indicate what the returns could be for these smaller assets, that are not publicly available.

Companies such as US-based renewable specialist NextEra Energy, which is up 19 percent in the year to date, have generally outperformed technology companies.

A further advantage is to be had from broadening beyond alternative energy into more defensive environmental sectors such as waste and water management.

Alternative energy is more likely to underperform in an economic slump when energy demand falls, along with prices for fossil fuels and political commitment to environmental subsidies. That contrasts with more predictable returns from infrastructure companies including waste management and water services.

BlackRock New Energy Fund invests at least 70 percent of its total assets in new energy companies including renewable energy, alternative fuels, automotive and on-site power generation, materials technology, energy storage and enabling energy technologies.

That compares with a broader investable universe targeted by fund manager Impax Environmental Markets, which includes renewable and alternative energy, energy efficiency, water technology and waste and pollution control. Returns have diverged since mid-2009 between the Impax fund, down 2 percent, and the BlackRock fund, down 30 percent. BlackRock did not respond immediately to a request for comment. Another way to diversify comes from using a broader definition of what constitutes an environmental company.

The looser the definition, the more opportunity for the investor to capture larger companies involved in more successful sectors such as energy efficiency, rather than just the smaller, technology specialists performing so poorly now.

The FTSE group has developed two different indexes to define environmental companies — one that includes businesses that derive at least 50 percent of their revenue from the sector and another for those with 20 percent.

The broader FTSE Environmental Opportunities Index, which includes giants such as Siemens and Philips, has dropped 9 percent in the past 12 months, compared with a fall of 26 percent for the FTSE ET50.

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